Dealers losing battle over uncleared swaps
The derivatives industry looks set to lose to regulators one of its most crucial lobbying battles, which could effectively kill off the market for bespoke OTC swaps. Such instruments are used by financial institutions to hedge interest rate and foreign exchange risk, and provide dealers with lucrative trading revenues.
For more than a year now, derivatives users, led by ISDA, have locked horns with regulators over initial margin requirements for uncleared swaps, arguing that current proposals could create systemic risk and harm the global economy by preventing crucial hedging activity.
“Sometimes, people overlook the fact that the derivatives market is needed by end-users to manage their risk,” said Fred Janbon, global head of fixed income at BNP Paribas. “If it disappears, companies won’t be able to issue bonds in foreign currencies and it could heavily impact their ability to export goods. If businesses can’t hedge their financial risks, it creates other risks to the economy.”
Now because derivatives are used SO MUCH amongst companies, their worried that to much regulation will boost commodities prices
Futures traders and exchanges are weighing in on the Commodity and Futures Trading Commission’s role in regulating their markets in the post-Dodd-Frank era.
At a hearing on Wednesday of the Senate committee that’s responsible for reauthorization of the CFTC, Terry Duffy, executive chairman and president of CME Group, and Adam Cooper, senior managing director and chief legal officer at Citadel LLC, presented their views on swaps execution, and a host of other issues.
Cooper, speaking on behalf of the Managed Funds Association, was wary of CFTC efforts to impose position limits more broadly pursuant to Dodd-Frank.
“We are concerned that inappropriate limits could reduce hedging activity, decrease market liquidity, and artificially raise commodity prices,” he said. “We believe position limits should be limited to the spot month where the deliverable supply of the commodity may be limited and thus subject to control and manipulation.”
Cooper urged Congress to amend Chapter 7 of the Bankruptcy Code so that, upon an FCM’s insolvency, customer assets posted as collateral on cleared swaps transactions would not be subject to pro rata distribution, as required under current law, The CFTC has adopted the legally segregated operationally commingled (LSOC) model for cleared swaps, which should reduce the likelihood of their being a customer asset shortfall in certain FCM default scenarios.
JP MORGAN CEO : “WE OPPOSES ANY REGULATION IN THE $ 600 TRILLION DERIVATIVE MARKET …….WE ARE FINE !! “
Billion-Trillion Derivatives Market! … Reform or a Blowup?
Derivatives Reform on the Ropes … New rules to regulate derivatives, adopted last week by the Commodity Futures Trading Commission, are a victory for Wall Street and a setback for financial reform. They may also signal worse things to come … The regulations, required under the Dodd-Frank reform law, are intended to impose transparency and competition on the notoriously opaque multitrillion-dollar market for derivatives, which is dominated by five banks: JPMorgan Chase, Goldman Sachs, Bank of America, Citigroup and Morgan Stanley. – New York Times
Dominant Social Theme: We have this billion trillion market under control. Don’t worry.
Free-Market Analysis: Derivatives reform? We hardly think so …
First of all, nobody knows how big the derivatives market is and no one knows how many dollars are at risk. Those involved in making the regulations are also the largest players in the market. Whatever “reform” is being worked out will benefit those who are part of the industry.
Here’s how Wikipedia describes a derivative:
A derivative is a financial instrument which derives its value from the value of underlying entities such as an asset, index, or interest rate–it has no intrinsic value in itself. Derivative transactions include a variety of financial contracts, including structured debt obligations and deposits, swaps, futures, options, caps, floors, collars, forwards, and various combinations of these.
To give an idea of the size of the derivative market, The Economist magazine has reported that as of June 2011, the over-the-counter (OTC) derivatives market amounted to approximately $700 trillion, and the size of the market traded on exchanges totaled an additional $83 trillion. However, these are “notional” values, and some economists say that this value greatly exaggerates the market value and the true credit risk faced by the parties involved. For example, in 2010, while the aggregate of OTC derivatives exceeded $600 trillion, the value of the market was estimated much lower at $21 trillion. The credit risk equivalent of the derivative contracts was estimated at $3.3 trillion.
Still, even these scaled down figures represent huge amounts of money. For perspective, the budget for total expenditure of the United States Government during 2012 was $3.5 trillion, and the total current value of the US stock market is an estimated $23 trillion.
The world annual Gross Domestic Product is about $65 trillion. And for one type of derivative at least, Credit Default Swaps (CDS), for which the inherent risk is considered high, the higher, notional value, remains relevant. It was this type of derivative that investment magnate Warren Buffet referred to in his famous 2002 speech in which warned against “weapons of financial mass destruction.” CDS notional value in early 2012 amounted to $25.5 trillion, down from $55 trillion in 2008.